September 23, 2007

The Road to Wigan Pier - Chapter 2 by George Orwell: Our civilization, pace Chesterton, is founded on coal.... The machines that keep us alive, and the machines that make machines, are all directly or indirectly dependent upon coal. In the metabolism of the Western world the coal-miner... is a sort of caryatid upon whose shoulders nearly everything that is not grimy is supported...

[...]

You get into the cage, which is a steel box about as wide as a telephone box and two or three times as long. It holds ten men, but they pack it like pilchards in a tin, and a tall man cannot stand upright in it. The steel door shuts upon you, and somebody working the winding gear above drops you into the void... the cage probably touches sixty miles an hour... at the bottom you are perhaps four hundred yards underground.... What is surprising... is the immense horizontal distances that have to be travelled underground.... If it is a mile from the pit bottom to the coal face, that is probably an average distance; three miles is a fairly normal one...
these distances bear no relation to distances above ground. For in all that for three miles as it may be, there is hardly anywhere outside the main road, and not many places even there, where a man can stand upright...

[...]

Down there where coal is dug is a sort of world apart.... Yet it is the absolutely necessary counterpart of our world above. Practically everything we do, from eating an ice to crossing the Atlantic, and from baking a loaf to writing a novel, involves the use of coal, directly or indirectly.... In order that Hitler may march the goose-step, that the Pope may denounce Bolshevism, that the cricket crowds may assemble at Lords, that the poets may scratch one another's backs, coal has got to be forthcoming.... Here am I sitting writing in front of my comfortable coal fire. It is April but I still need a fire.... It is only very rarely, when I make a definite mental-effort, that I connect this coal with that far-off labour in the mines...

Ross Douthat: If you want to rebut [Fred] Thompson's claim [that Americans "have shed more blood for other people's liberty than any other combination of nations in the history of the world"], might I suggest that arguing that Stalin's Red Army was fighting for "other people's liberty" probably isn't the best way to do it?

In the 245 messages in my email inbox right now I notice the names of two people in particular. One of them had a grandfather from the Ukraine who was inducted into Stalin's Red Army just before June 22, 1941. He fought all the way backward from Lvov to Stalingrad, and then all the way forward from Stalingrad to Berlin. He survived. The other of them had a grandfather who was inducted into Stalin's Red Army just after June 22, 1941. He was dead within a month.

Ross Douthat may think that in fighting against the Nazis my two friends' grandfathers were fighting for genocide and slavery. I don't think so.

The debt all of us owe to the soldiers of the Red Army and the workers of Magnitogorsk is still outstanding. That they were Stalin's victims does not cancel the debt.

Atrios reads the Washington Post--which nobody should have to do--and finds Chris Cillizza And Shailagh Murray. The lead:

In Swing Districts, Democratic Enthusiasm Is Harder to Come By: Conventional wisdom dictates that Democratic voters are thrilled with their choices for president, bursting at the seams to rally behind Sen. Hillary Rodham Clinton (N.Y.), Sen. Barack Obama (Ill.) or whoever gets the party's nod next year. A recent survey by Democratic pollster Celinda Lake, however, showed Clinton and Obama trailing former New York mayor Rudolph W. Giuliani (R) in the 31 Democratic-held House districts regarded as most imperiled in 2008, and even potentially serving as a drag on those lawmakers' reelection chances. The poll was conducted in August but has not been previously reported. It paints a "sobering picture" for Democrats, according to a memo by Lake and Daniel Gotoff that accompanies the poll report...

Atrios writes:

Blogger Ethics Panel: So why is "Democratic pollster" Celinda Lake running push polls about Obama and Clinton? Why are Cillizza and the Devil running them as news? More importantly, why isn't Cillizza telling us that Celinda Lake works for the rival Biden campaign? I know he knows this, because he told me himself...

Indeed, Cillizza did:

Celinda Lake Joins Biden's 2008 Team: If Sens. Hillary Rodham Clinton (Ill.) and Barack Obama (Ill.) are the hares of the 2008 Democratic nomination race, Sen. Joe Biden (Del.) is aiming to be the tortoise. While the announcements of Clinton and Obama have dominated the news over the past week, Biden continues to soldier on -- slowly building a national political team. The latest addition to the team is Celinda Lake, who will handle polling for Biden's presidential effort. Lake, a well-known pollster among the chattering class, had a very good 2006 as the lead pollster for Sen. Jon Tester (D-Mont.) as well as Rep. Jerry McNerney (D-Calif.) and Tim Walz (D-Minn.). All three beat Republican incumbents...

And it's true: the name of Celinda Lake's employer, Joe Biden, doesn't appear in the Cillizza-Murray article. And the wording of Lake's question?

"Some people say [your Democratic incumbent] is a strong supporter of Hillary Clinton and will support her liberal agenda of big government and higher taxes if she becomes president," the poll stated, before asking respondents whether they would still vote for their incumbent or choose a Republican candidate...

Econbrowser: Money creation and the Federal Reserve: There seem to be some misconceptions about the monetary consequences of actions that the Federal Reserve has taken to address liquidity needs.... I hope in this post to get beyond these sound bites, beginning if I may with some details of the process whereby money is created in the United States. Where did the cash in your wallet come from? Presumably you got it from your bank or ATM. And the reason that the bank was willing to give you that cash was that you already had deposits in an account with the bank, which were in effect credits to obtain cash when you wanted it.

And where did your bank get that cash? If it is a member of the Federal Reserve, your bank got it from a Federal Reserve Bank... your bank had deposits in an account with the Fed, that give it credits to obtain cash when it wants it.... And where did those reserves come from?... the Fed purchased Treasury bills... paying for them by creating new reserves in the dealers' banks. The Fed now is the owner of the Treasury bills, and those banks now have new reserves, which they could use to obtain new dollar bills, if they desired.

To follow what's happened over the last 6 weeks, it's necessary to add a few details to this basic story. For day-to-day fine-tuning of interest rates and the money supply, the Fed usually does not use outright purchases of Treasury securities, but is more likely instead to rely on repurchase agreements... on any given day the Fed's outstanding repos have created reserves and thus potential dollars in circulation... for the week ended August 8, just before the summer fireworks... the Fed held $791 billion in Treasury securities and $19 billion in repos....

Beginning August 9, the Fed aggressively used repos.... The hundred billion dollar figure that some people use comes from adding together each day's repo operations, which is a completely nonsensical calculation. At the height of these operations (the week of August 9-15), Fed repos created an average of $18 billion in new daily reserves....

[W]hat exactly happened to that $18 billion while it was in the banking system? The answer is-- absolutely nothing. Banks simply held these funds as excess reserves, with nobody withdrawing a single dollar bill. This tremendous increase in banks' desires to hold reserves beyond the amount that they were required was one of the remarkable aspects of this situation and the primary reason that the Fed needed to conduct such repo operations in the first place... reserve balances are now right back where they were on August 8, and currency in circulation is in fact $3 billion lower than it was. The Fed has done its job, and the kvetchers have done theirs....

Now, I realize that this explanation may not be as entertaining as the whole Helicopter Ben meme. But on the other hand, it may be a whole lot more accurate...

Damn Interesting » Building the BAM: The tunnels were particularly troublesome. The unswerving straight-line commitment of the original Soviet planners meant that in a number of cases, tunnels were built unnecessarily: later geological reviews suggested that acceptable diversions through easier terrain were possible at greatly reduced cost and with minimal increase in the distance of the track. Yet with commendable enthusiasm the Soviets dug onwards. The Dusse-Alin Tunnel was successfully built in the Stalin era without any survey work whatsoever; incredibly, when the two tunnelling teams of BAMlag workers met in the middle, they were out of alignment by only 20cm. But while the passage lay abandoned for twenty years, water seeped in through the bedrock and froze solid. The dismayed railway engineers of 1974 were left with the problem of dealing with 32,000 tonnes of ice blocking the shaft--and also of disposing of the frozen bodies of the gulag workers they frequently stumbled on while reconditioning the tunnel. When all else failed, the Soviets resorted to raw power. The workers jury-rigged an aircraft jet engine at one end of the tunnel, and hit the ignition. Its stream of superheated exhaust rapidly blasted a path through the wall of ice, clearing the tunnel for further work.

I really think that in ten years the Republican Party may be dead because of this man. The Republicans survived Nixon because they turned on them. But they haven't turned on Bush--they are still marching like lemmings over the cliff (which lemmings don't do, being considerably smarter and more public-spirited than Republicans).

Sidney Blumenthal:

Sidney Blumenthal: Bush's stairway to paradise: Hoping that history will somehow vindicate him, the president has entered a phase of decadent perversity: There has never been a moment when we were not winning in Iraq. Victory has followed victory, from "Mission Accomplished" to the purple fingers of the Iraqi election to, most recently, President Bush's meeting at Camp Cupcake in Anbar province with Abdul-Sattar Abu Risha, the Sunni leader of the group Anbar Awakening (who was assassinated a week later). Turning point has followed turning point, from Bush's proclamation two years ago of his "National Strategy for Victory in Iraq" to his announcement last week of his "Return on Success." "We're kicking ass," he briefed the Australian deputy prime minister on Sept. 6 about his latest visit to Iraq. In his quasi-farewell address to the nation on Sept. 13, Bush assigned any possible shortcomings to Gen. David Petraeus and bequeathed his policy "beyond my presidency" to his successor....

In his semiretirement, Bush engaged in appeals to history, which he now says on nearly every occasion will absolve him. Early on and riding high, he expressed contempt for history. "History, we'll all be dead," he sneered to Bob Woodward in an interview for "Bush at War," a panegyric to Bush the triumphant after the Afghanistan invasion and before Iraq. Now Bush cites history as justification for everything he does. "You can't possibly figure out the history of the Bush presidency -- until I'm dead."... Frederick Kagan, the neoconservative instigator of "the surge," refers to it as "Gettysburg," a leap of historical imagination that transforms Bush into the Great Emancipator.... Bush has become as certain of his exalted place in history as he is of his policy's rightness....

Draper's biography... lacks any serious discussion of... Cheney... neoconservatives, Karl Rove's attempt to create a one-party state... torture... splits within the senior military, the scapegoating of the CIA.... Draper's unusual access enabled him to collect valuable anecdotes as well as to put a microphone in front of a president who, when interrupted by an aide, told him not to worry because the interview was "worthless.."...

[Bush] is constantly worried about weakness and passivity. "If you're weak internally? This job will run you all over town." He fears being controlled and talks about it relentlessly, feeling he's being watched.... He is sensitive about asserting his supremacy over others, but especially his father....

Bush is a classic insecure authoritarian who imposes humiliating tests of obedience on others in order to prove his superiority and their inferiority.... When Colin Powell was several minutes late to a Cabinet meeting, Bush ordered that the door to the Cabinet Room be locked.... [W]hen Matthew Dowd and Rove explained to him that he was not likely to win in a Reagan-like landslide, as Bush had imagined, he lashed out... and shouted, "You don't know what the hell you're talking about."

Those around him have learned how to manipulate him through the art of flattery. Former Secretary of Defense Donald Rumsfeld played Bush like a Stradivarius, exploiting his grandiosity. "Rumsfeld would later tell his lieutenants that if you wanted the president's support for an initiative, it was always best to frame it as a 'Big New Thing.'"... Every morning, Josh Bolten, the chief of staff, greets Bush with the same words: "Thank you for the privilege of serving today."...

The elder Bush assumed that the Bush family trust and its trustees -- James Baker, Brent Scowcroft and Prince Bandar -- would take the erstwhile wastrel and guide him on the path of wisdom.... [George W.] Bush was entrusted to the care of the trustees.... [H]e was ill-prepared and ignorant, but they never expected him to be assertive....

The elder Bush knew that Rumsfeld despised him and that Cheney was close to Rumsfeld, just as he knew his son's grievous limitations. But the obvious didn't occur to him.... The elder Bush committed a monumental error, empowering a regent to the prince who would betray the father.... Cheney... was extremely convincing in playing possum. The elder Bush has many reasons for self-reproach, but perhaps none greater than being outsmarted by a courtier he thought was his trustee...

It reached parity with the Canadian dollar today. Paul Krugman writes:

Is This the Wile E. Coyote Moment?: Lots of buzz suddenly about the possibility of a sharp fall in the dollar.... A nice summary at Barry Ritholtz’s blog The Big Picture.... [T]he problem is that I’ve been seeing it coming for several years, and it keeps not arriving.... [T]he U.S. trade deficit is, fundamentally, not sustainable in the long run, which means that sooner or later the dollar has to decline a lot. But international investors have been... betting that the dollar won’t ever decline.

So, according to the story, one of these days there will be a Wile E. Coyote momen... the dollar... who has run off a cliff, looks down and realizes that he’s standing on thin air--and plunges.... Maybe the dollar’s Wile E. Coyote moment has arrived – although, again, I’ve been wrong about this so far...

The Seventeen-Year-Old is going to college next year, which means that I need to think about making more money. (The idea that one might write checks to rather than receive checks from universities is now strange to me.) So I have signed up with the Leigh Speakers' Bureau, which also handles:

John Maynard Keynes on the meme that the speculators--and others--must suffer:

John Maynard Keynes: While some part of the investment which was going on in the world at large was doubtless ill judged and unfruitful, there can, I think, be no doubt that the world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history.... Doubtless, as was inevitable in a period of such rapid changes, the rate of growth of some individual commodities [over 1924-1929] could not always be in just the appropriate relation to that of others. But, on the whole, I see little sign of any serious want of balance such as is alleged by some authorities. The rates of growth [of different sectors]seem to me, looking back, to have been in as good a balance as one could have expected them to be. A few more quinquennia of equal activity might, indeed, have brought us near to the economic Eldorado where all our reasonable economic needs would be satisfied....

It seems an extraordinary imbecility that this wonderful outburst of productive energy [over 1924-1929] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man's speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a 'prolonged liquidation' to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again.

I do not take this view. I find the explanation of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity...

At the end of January 2006 the Iraqi government issued roughly $2.7 billion of debt in exchange for over $20 billion of Saddam-era commercial claims. I use variation in the price of this sovereign debt to evaluate pacification policy in Iraq. Structural change models are run in conjunction with conventional event study analysis. The techniques applied provide an additional vehicle to "objectively" inform policy in areas where data collection is difficult and policies are time sensitive. Results suggest that sectarian violence was the biggest threat to Iraqi stability in the period analyzed. I find that military operations alone did not sufficiently address Iraq's security problems. The market viewed political negotiations between the interested parties as the most effective stabilization policy. It appears, however, that negotiations among Iraqi parties have reached a dead-end. In the absence of regional (especially Iranian) cooperation the prospects for Iraq's current government seem dim.

I especially thank Eric Chaney for alerting me to the existence of Iraqi government bonds...

Background. Before analyzing these time series, it is informative to know the history of the Iraqi bonds, some details on how bonds are priced on secondary bond markets, and why it is reasonable to assume that world financial markets can efficiently aggregate the available information on Iraq’s future. Prior to Iraq’s invasion of Kuwait in 1990, Iraq issued about $130 billion in debt. After the Gulf war, they defaulted on this debt. When the US led coalition invaded Iraq in 2003, the holders of this debt were spread around the world. The Paris Club held claims of approximately $40 billion, Persian Gulf creditors had another $65 billion and the remainder was in the hands of commercial creditors (Chaney 2007)...

A trader at JP Morgan said that "As much as 90% may have gone from the original holders (banks, trading companies, engineering firms etc., i.e., not investment funds) to investment funds. And of that [the bond are] are about evenly split between hedge funds and “real money” accounts (maybe slightly more in “real money”)." [Quoted in Chaney (2007), page 4]. Further there has been substantial trading of these bonds; about $4.1 billion of these bonds were traded in the first quarter of 2006 when they were issued and roughly $1.6 billion in the second quarter (Chaney 2007)...

Fed Risked Creating Moral Hazard?: Federal Reserve Chairman Ben Bernanke and his colleagues clearly explained why they cut interest rates this week by one-half percentage point: "To help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets."

But a vocal chorus is complaining that Bernanke & Co., instead, just bailed out a bunch of greedy speculators, imprudent lenders and short-sighted home buyers who got too-good-to-be-true mortgages. "This is like adding Jack Daniels to the AA-meeting punch bowl," emailed Rob Brantley, a Washington consultant. "The market's reaction provides proof." "I plan to now sell my house and upgrade to a $4 million or $5 million home in Highland Park. If I find I can't meet my mortgage payments, will Mr. Bernanke bail me out?" Cheryl Kawalsky emailed from Dallas. "Or, is that type of American socialism reserved for hedge-fund managers, investment bankers, and private-equity moguls? The truth is, in America today, I feel like I'm living in a huge house overrun by children. All the adults have left town."...

The more provocative attacks -- which come both from left and right -- accuse the Fed of encouraging people to take foolish risks by cutting rates now to protect them from harm.... Harvard's Richard Zeckhauser puts it in the Concise Encyclopedia of Economics. "Federal deposit insurance made savings and loans more willing to take on risky loans. Federally subsidized flood insurance encourages citizens to build homes on flood plains."... "Providing [after-the-fact] insurance for risk behavior ... encourages excessive risk-taking and sows the seeds of a future financial crisis," the governor of the Bank of England, Mervyn King, said with conviction Sept. 12, a few days before he and the British government had to move from the sidelines to fight a bank run.

But there also is an ethical dimension to the criticism, a righteous indignation at speculative excess. "There's a definite feeling, when the crisis comes along, that these un-Christian people are getting their comeuppance," says Brad Delong, an economic historian at the University of California, Berkeley. He cites British thinker Edmund Burke in 1790, bemoaning the ascendance of financiers following the French Revolution, who said, "The age of chivalry is gone; that of sophisters, economists, and calculators has succeeded, and the glory of Europe is extinguished forever."

Lower short-term interest rates do help banks that borrow in the short term and lend for the long term.... But there are moments -- and this may be one -- where one can worry too much about moral hazard. As Fed officials have quipped: We want to discourage people from smoking in bed, but do we want to prevent the fire department from putting out fires caused by such carelessness? Or, to paraphrase Charles Kindleberger, the late Massachusetts Institute of Technology economic historian: In a speculative boom, one wants to stir doubt as to whether the lender of last resort will step in. But when the bust comes, one certainly wants him to show up.

At times like these, it is the Fed's job to make sure the financial system functions.... [T]he Fed [should not] hesitate to cut rates or otherwise intervene when financial panic imperils otherwise sound investments and businesses; otherwise, people will be reluctant to make such sound investments in the future and the overall economy will suffer. At times like these, there is a danger that a principled stand to punish the profligate could inflict severe economic pain on millions of innocent bystanders...

September 19, 2007

Brad DeLong--Economics Only: What Is to Be Done? (About the Subprime Meltdown, That Is): Thanks for linking to my notes. I think you misunderstand my point #5, where the key word is "federal." Ned Gramlich pointed out that half of subprime mortgages in 2005 were issued by mortgage companies chartered and supervised by the states (compared with essentially no prime mortgages), and that the problem mortgages are heavily concentrated in that sector. He concluded in his book that all mortgage lenders should be covered by a federal supervisor. Others have argued that federal supervision is important for the Fed's ability to restore liquidity to these institutions.

However, in Ned's Jackson Hole remarks, he said that the same regulatory end might be achieved by collaboration among federal and state supervisors, which was already underway. My notes cited this point and added some other reasons why I thought replacing state supervision with federal supervision was not needed (at least for these reasons--whether our overall supervisory structure makes sense is a harder issue). I was not arguing for no supervision of these institutions at all. I wonder, though, about your argument that any institution "borrowing short and lending long" is like a bank and needs to be regulated. I see your logic, but doesn't it apply to essentially all issuers of commercial paper?

On my point #6 about credit ratings agencies, I wish I had better ideas than I do. But regulators can, at the least, illuminate the potential conflict of interest between rating securities and soliciting business from securities issuers, and generate more separation between these functions within those organizations. However, I would not (and hope I do not in my notes) overstate the likely effectiveness of these steps.

Perhaps I am an old-fashioned person, but I believe that no rating agency has any business rating any commercial paper AAA or AA unless that commercial paper is in fact commercial paper--unless it is collateralized by short-term accounts receivable. That is, in its origins, what commercial paper is: you have short-term accounts receivable and you want to turn that wealth into something liquid, so you sell your short-term accounts receivable for cash.

With respect, Paul Krugman has nothing to with this. In June 2002, the Commerce Department announced that its final estimate of GDP growth for the first quarter was 5.6 per cent. To be sure, the GDP figures have since been revised down, but Greenspan was reacting to contemporary data. In addition, the revised figures still show growth of 2.7 percent and 2.4 percent in the first two quarters of 2002. Given the widespread fears of a recession after 9/11, it seems to me, and it seemed to others at the time, that the 2002 recovery was, indeed, an amazingly robust one.

As to how to interpret Greenspan's public comments about the likelihood of a recession, which spooked the markets at the beginning of this year, that is a matter of opinion, and you are as entitled to yours as I am to mine. I would just put to you one question: Can anybody imagine Paul Volcker putting himself in the same situation?

Brad, you are forever berating economic journalists. Some of that is healthy: we all make mistakes. But somebody who sets himself up as a professional arbiter needs to have high standards. In this instance, the quality of your research was unworthy of a wire service rookie, let alone a tenured professor at a prestigious university.

Let me just present one more piece of data, apropos of Cassidy's claim that by the summer of 2002 it was clear to all intelligent observers that the danger that the U.S. would fall into a Japan-style deflation was past. He may say that Paul Krugman's 2002 fears of deflation "have nothing to do with this." Will he say the same thing about John Berry? :-)

Federal Reserve officials, concerned there is still no sign of the solid pickup in U.S. economic growth needed to foreclose the possibility of deflation, appear certain to cut their target for overnight interest rates next week. There is broad agreement among investors and analysts that a rate cut is coming, but there is disagreement about whether policymakers will lower their 1.25 percent target by a quarter-percentage point or by a half-point. The latter seems to be more likely as a sort of exclamation point to emphasize that the officials believe this will be the final step that, coupled with the income tax cut that will show up in workers' take-home pay next month, will put the economy on a strong, sustainable growth path.

Fed Chairman Alan Greenspan, who gave the first hint that he was contemplating another rate cut in testimony before a congressional committee on May 21, referred then to such a step as "taking out insurance." "We believe that because in the current environment the cost of taking out insurance against deflation is so low, that we can aggressively attack some of the underlying forces, which are essentially weak demand," Greenspan told the committee. Several other Fed officials have expressed similar views in recent weeks. By "cost" Greenspan meant the risk that another rate cut could so stimulate economic activity that it would cause inflation to become significantly worse. But in this instance, such an outcome would almost be welcome.

A rate cut by the central bank next week would be the 13th since January 2001 on the eve of a recession when the rate target was 6.5 percent. The Greenspan-led Fed cut rates aggressively as the economy contracted through that year, and growth resumed in 2002. But to the surprise of economists and policymakers, the recovery has been halting and "jobless" despite huge doses of monetary and fiscal stimulus. The U.S. unemployment rate, which had fallen to 3.9 percent in the fall of 2000, was 6.1 percent last month. Now, again, many forecasters are predicting that economic growth will accelerate. They are saying the pickup will occur in the second half of this year, to a fast, sustainable pace that will begin to add jobs and put much of the nation's idle production capacity back to use. Greenspan and his Fed colleagues don't necessarily think those forecasts are wrong; they just aren't convinced they are right.

Gary H. Stern, president of the Minneapolis Federal Reserve Bank, said in an interview Monday that when he talks with bankers and business executives around his sprawling district, which runs from the Upper Peninsula of Michigan to the mountains of western Montana, "the tenor of the conversations is clearly more upbeat than they were at the turn of the year. It's not all bright and sunny, but the sense I got is that business is starting to improve." But Stern stressed: "I do not want to exaggerate this. . . . It is certainly not reflected in the current quarter's data. Will it be reflected in the third quarter? Who knows?"

What has added a sense of urgency to next week's policymaking session is the rapid, unexpected decline in the U.S. inflation rate this year. The core consumer price index, which excludes volatile food and energy prices, was up at only a 1 percent annual rate over the past three months. Another measure closely followed by many Fed officials, the core price index for personal consumption expenditures, rose at about the same 1 percent annual rate in the six months ended in March, and analysts are predicting a similar number for the current quarter.

The Fed's concern is the "minor probability" that this drop in the inflation rate could turn into a deflation, which Stern defined in a talk this week as "a sustained period of decline in a broad measure of prices." There is a consensus among policymakers that the probability of that happening "is low, but the consequences if we experience it possibly would be severe," he said. In a deflation, declining prices could force employers to reduce wages, make it harder for borrowers to repay debts, seriously hurt economic growth and make it more difficult for the central bank to use monetary policy to stimulate a slumping economy. That's because interest rates cannot effectively fall below zero. During a deflation, inflation-adjusted interest rates could therefore still be positive and restrain economic growth even when the nominal interest rate was zero.

Fed officials have said they could use other methods to pump money into the economy even if the overnight rate fell to zero. But Greenspan has said the lack of experience in dealing with such a situation means the Fed cannot be certain how things would work out, so it is far better to avoid a deflation in the first place. "The Fed is not panicking and believes the economy will pick up, most likely rendering the deflation issues less relevant in the longer run," said economist Peter E. Kretzmer at the Bank of America in New York. "Further, the Fed is confident it has the nonstandard tools to end a deflation." But Kretzmer, like many analysts, expects the Fed to lower rates next week, in part because the officials' recent statements about deflation have convinced financial markets such a cut is on the way. Balancing market expectations with some signs that the economy stabilized last month, the Fed is likely to lower the target by a quarter point, he predicted.

In contrast, economist Ken Kim at Stone & McCarthy, a financial market research firm, said he expects a half-point cut, given the notion of "insurance" behind the action and the absence of worry about excessive inflation.

How Google Killed Web Subscriptions: How Google Killed Web Subscriptions: Everybody knows that Google has won the search-engine war. But what's much more important is that Google has won the search war – and the latest casualty is TimesSelect. The subscriber firewalls at the WSJ and the FT will be the next to go.

Until Google came along, most content-based websites had a similar business model: users would come to the site's home page, search for what they were looking for, and then find it. So if you wanted a NYT story, you'd first go to nytimes.com, and then search. If you wanted a Wikipedia article, you'd first go to wikipedia.org, and then search.

No longer.

When I want to find one of my old blog entries on portfolio.com, I just type the search terms into the Google window in my browser. When I want to find a Wikipedia entry, I do the same thing, in the knowledge that Wikipedia's PageRank will guarantee that entry a top-two spot. Google's even very good at finding books on Amazon...

And if you think what you want is probably at a particular site, just add the site's name to your search string: "amazon", "wikipedia", "portfolio."

But Google is very bad at pointing people to anything behind a subscriber firewall – and rightfully so. What changed, The Times said, was that many more readers started coming to the site from search engines and links on other sites instead of coming directly to NYTimes.com...

“What wasn’t anticipated was the explosion in how much of our traffic would be generated by Google, by Yahoo and some others,” Ms. Schiller said.

When was the last time you saw a WSJ or FT article on a web search? As people increasingly get their information from Google and not from home pages, the WSJ and FT websites have a choice: go free, or become irrelevant. The WSJ certainly can't be happy that Nick Denton, with his shoestring operation, gets more traffic, and more visitors, than they do. As Jeff Jarvis says today, the really valuable thing that the WSJ and the FT provide is not their news, but their relationship with their readers.... It’s the relationship that is profitable.... That is the essential media moral of the internet story. It has taken 13 years of internet history for media companies to learn that.... Google doesn't weaken the strength of the relationship.... [I]t just changes the way that readers find their trusted content. If a WSJ story comes up top of a Google search, people will click on it because they trust the WSJ. And because people trust the WSJ, WSJ stories will come up top of a Google search. It's win-win for all concerned, and, yes, Rupert Murdoch knows it.

Except for the money flows. It is not clear how large the advertising money flows will be in the long run. Especially if people continue to offer print-format versions of their articles that allow you to escape the ads.

I suspect we are headed for a winner-take-all situation here as well: journalists who acquire reputations as experts will do very well as they become draws for advertisers. Institutions--not so much. Anybody who trusted the New Republic under Michael Kinsley and then encountered the New Republic under Andrew Sullivan, Michael Kelly, and Peter Beinart learned a very painful lesson about focusing on institutions rather than people.

Perhaps the strangest thing about Robert Lucas's "Mortgages and Monetary Policy" is his insistence that over the past twenty years "if we have learned anything... it is that there is a lot of stability built into the real economy." What planet does he live on? There was not "a lot of stability built into the real economy" in Japan in the 1990s. Nor was there "a lot of stability built into the real economy" in Mexico in 1994-1995. Nor was there "a lot of stability built into the real economy" in Korea, Malaysia, Indonesia, and Thailand in 1997-1998. On this planet, the lesson of the past twenty years is that very small shocks in financial markets can snowball and destabilize the real economy.

I wish we lived on Planet Lucas. But alas! I don't think we do.

The rest of it is almost as strange:

In the past 50 years, there have been two macroeconomic policy changes in the United States that have really mattered. One of these was the supply-side reduction in marginal tax rates, initiated after Ronald Reagan was elected president in 1980 and continued and extended during the current administration.... As a result... steady GDP growth, low unemployment rates and low inflation rates -- once thought to be an impossible combination -- have been a reality in the U.S. for more than 20 years...

Growth was not steady--growth was in fact quite slow and uneven--during the Reagan-deficit years from 1982-1993. The limited data seem to suggest that perhaps a federal budget in rough medium-run balance is important as well. Surely this is worth a mention? If you are going to talk about things that start in 1994-1995, you probably shouldn't date them back to 1981. This is the Wall Street Journal editorial page--and it is a bad intellectual neighborhood. But just because your in a bad intellectual neighborhood is no excuse.

And there is this:

The other [good change] was the advent of "inflation targeting," which is the term I prefer for a monetary policy focused on inflation-control to the exclusion of other objectives...

There are lots of monetary policies focused on inflation-control to the exclusion of other objectives. A gold standard. A silver standard. Some Fisherian commodity-basket standard. A fixed monetary base. A k% per year growth rate for the monetary base. A k% per year growth rate for checking accounts. A k% growth rate for some broader liquidity aggregate. Lucas says he likes "inflation targeting" and then several paragraphs later goes on to reject the inflation targeting framework:

[A] line of argument that seems to me much less compelling... that monetary policy necessarily affects future inflation rates, not the current rate... whatever funds rate target is chosen, all kinds of others forces -- anything that happens to the real economy -- will affect next quarter's rate of inflation, or next year's. So we would like to forecast these other forces as well as possible and take them into account.... [I]nflation forecasting is notoriously one of the squishiest areas of economic statistics. In this situation, it is all too easy for easy money advocates to see a recession coming and rationalize low interest rates. They could be right -- who really knows? -- and in any case we may not know enough to prove them wrong...

The line of argument that Lucas sees as "much less compelling" is nothing other than inflation targeting: that the Federal Reserve should use the information it has to target the inflation rate. If Lucas doesn't like inflation targeting, fine. But he shouldn't try to capture the good reputation inflation targeting has for something he prefers that is not inflation targeting.

In fact, he never tells us what he does prefer: A gold standard? A silver standard? Some Fisherian commodity-basket standard? A fixed monetary base? A k% per year growth rate for the monetary base? A k% per year growth rate for checking accounts? A k% growth rate for some broader liquidity aggregate? All of these differ from inflation targeting because they ask the Federal Reserve to throw away some information because it is not trusted to use it well. One or more of them may well be better than inflation targeting. But which? And why?

Robert Shiller writes about worldwide bubble trouble. In Shiller's view, Alan Greenspan is broadly right in his belief that the Federal Reserve could not have popped the housing bubble without inflicting unacceptable collateral damage on employment and production:

The boom, and the widespread conviction that home prices could only go higher, led to a weakening of lending standards... [and] a number of financial innovations... all would be well, the reasoning went, on the premise that home prices continue to rise at a healthy pace.

At the Jackson Hole conference, Paul McCulley of PIMCO... argued that in the past month or two we have been witnessing a run on what he calls the "shadow banking system"... the levered investment conduits.... Bank runs occur when people, worried that their deposits will not be honored, hastily withdraw their money, thereby creating the very bankruptcy that they feared. It is no coincidence that this new kind of bank run originated in the U.S., which is the clearest example of falling home prices in the world today....

The U.S. Federal Reserve is sometimes blamed for the current mortgage crisis, because excessively loose monetary policy allegedly fueled the price boom that preceded it. Indeed, the real (inflation-corrected) federal funds rate was negative for 31 months, from October 2002 to April 2005.... But loose monetary policy is not the whole story. The unusually low real funds rate came after the U.S. housing boom was already well under way.... Alan Greenspan, the former Fed chairman, recently said that he now believes that speculative bubbles are important driving forces in our economy, but that, at the same time, the world's monetary authorities cannot control bubbles. He is mostly right: the best thing that monetary authorities could have done, given their other priorities and concerns, is to lean against the real estate bubble, not stop it from inflating.

The current decline in home prices is associated just as clearly with waning speculative enthusiasm among investors, which is likewise largely unrelated to monetary policy. The world's monetary authorities will have trouble stopping this decline, and much of the attendant problems, just as they would have had trouble stopping the ascent that preceded it...

Amid the Federal Reserve's cut of U.S. interest rates on Tuesday, the show examines what the central bank has done, why and what it portends for the U.S. and the global economy. Guests include John B. Taylor, professor of economics at Stanford, senior fellow at the Hoover Institute and author of "Global Financial Warriors"; Brad DeLong, professor of economics at UC Berkeley and research associate at the National Bureau of Economic Research; and Ethan Harris, chief U.S. economist at Lehman Brothers Holdings, Inc.

I was born in 1953. Like the rest of my generation, I took the America I grew up in for granted – in fact, like many in my generation I railed against the very real injustices of our society, marched against the bombing of Cambodia, went door to door for liberal candidates. It’s only in retrospect that the political and economic environment of my youth stands revealed as a paradise lost, an exceptional episode in our nation’s history.

That’s the opening paragraph of my new book, The Conscience of a Liberal. It’s a book about what has happened to the America I grew up in and why, a story that I argue revolves around the politics and economics of inequality.

I’ve given this New York Times blog the same name, because the politics and economics of inequality will, I expect, be central.... In fact, let me start this blog off with a chart that’s central to how I think about the big picture, the underlying story of what’s really going on in this country. The chart shows the share of the richest 10 percent of the American population in total income – an indicator that closely tracks many other measures of economic inequality – over the past 90 years, as estimated by the economists Thomas Piketty and Emmanuel Saez....

The Long Gilded Age:... In many important ways, though, the Gilded Age continued right through to the New Deal.... Public policy did little to limit extremes of wealth and poverty... working Americans were divided by racial, religious, and cultural issues.... The Great Compression: The middle-class society I grew up in... was created, in a remarkably short period of time, by FDR and the New Deal.... [I]ncome inequality declined drastically from the late 1930s to the mid 1940s.... Middle class America: That’s the country I grew up in... a society without extremes of wealth or poverty... of broadly shared prosperity, partly because strong unions, a high minimum wage, and a progressive tax system helped limit inequality... a society in which political bipartisanship meant something... in spite of the sinister machinations of Nixon and his henchmen.... The great divergence: Since the late 1970s the America I knew has unraveled. We’re no longer a middle-class society, in which the benefits of economic growth are widely shared: between 1979 and 2005 the real income of the median household rose only 13 percent, but the income of the richest 0.1% of Americans rose 296 percent.

Most people assume that this rise in inequality was the result of impersonal forces, like technological change and globalization. But the great reduction of inequality that created middle-class America between 1935 and 1945 was driven by political change; I believe that politics has also played an important role in rising inequality since the 1970s.... no other advanced economy has seen a comparable surge in inequality – even the rising inequality of Thatcherite Britain was a faint echo of trends here.

On the political side, you might have expected rising inequality to produce a populist backlash. Instead, however, the era of rising inequality has also been the era of “movement conservatism,” the term both supporters and opponents use for the highly cohesive set of interlocking institutions that brought Ronald Reagan and Newt Gingrich to power, and reached its culmination, taking control of all three branches of the federal government, under George W. Bush... taxes on the rich have fallen, and the holes in the safety net have gotten bigger, even as inequality has soared. And the rise of movement conservatism is also at the heart of the bitter partisanship that characterizes politics today...

Notes on Policy Responses to the Subprime Mortgage Unraveling: In recent months, rising delinquencies and foreclosures of subprime mortgages have caused turmoil in broader financial markets, raised fears that many subprime borrowers could lose their homes, and led economic forecasters to boost the estimated odds of a recession next year. These
economic and financial developments raise... broad policy questions.... These notes offer my answers.... My goal is not to be original, but rather to present a compilation and critical appraisal of many ideas that have been discussed by analysts.... I conclude:

The Federal Reserve should reduce, but not slash, the federal funds rate, unless stronger evidence emerges of a freezing-up in credit markets or a significant slowing in overall economic activity.

Monetary policy should have been slightly less expansionary in 2004 and 2005, but this would not have materially altered recent events.

The government should help struggling households to refinance their mortgages, but this help should be reasonably narrowly targeted and should avoid harming the mortgage market and other financial markets in the long run.

The government should place greater restrictions on the mortgages offered to riskier borrowers, but it should try not to dampen financial innovation generally.

Federal banking supervision does not need to be extended to all mortgage lenders.

However, the government should strengthen its oversight of credit rating agencies.

I disagree with Elmendorf's (6): I do not really see what the government can do in the credit-rating field that is likely to be useful. I also disagree with (5): anything that is a bank--that leverages its capital by borrowing short and lending long and in the process tells those from whom it borrows that their assets are more liquid than its assets--needs to be under the regulatory umbrella to some degree; and mortgage lenders are definitely banks in this sense.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 5-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, St. Louis, Minneapolis, Kansas City, and San Francisco.

This is an amazingly popular video game. Of the eighteen vehicles I passed on Fish Ranch, Grizzly Peak, and Panoramic, six were playing it...

There appears to be a serious bug in the graphics module of my copy. Today the extraordinarily beautiful hi-res graphics of San Francisco Bay were replaced by a featureless grey background. I must figure out how to reboot...

The key to winning going toward Berkeley appears to be to use a light foot on level 1--coming down into Orinda center form the west--and then a heavy foot on level 2--Orinda center to Fish Ranch. That starts the process of discharging the battery so you arrive at the top of Grizzly Peak with enough spare capacity.

Winning going away from Berkeley is child's play: you cannot climb from the campus up to the Lawrence Hall of Science without a nearly complete battery discharge.

Matthew Yglesias asks "why." The answer, Matt, is that the Washington Post is not a news gathering organization:

Matthew Yglesias: This "news analysis" from Peter Baker and Jonathan Weisman in yesterday's Washington Post was so ridiculous that I couldn't bring myself to complain about it on a low traffic Tuesday. As many people as possible need to slam their collective heads against the wall and ask themselves why. Why people would actually be paid money to write this lead:

When Army Gen. David H. Petraeus last week proposed withdrawing more than 20,000 U.S. troops from Iraq, some congressional Democrats nodded their heads and saw it as a positive, if insufficient, step forward. Some wanted to take credit. After all, they reasoned, the drawdown, the benchmarks report, even Petraeus's Capitol Hill testimony came about only because of Democratic pressure.

Within hours, that idea was shot down. When House Democratic leaders convened in the office of Speaker Nancy Pelosi (Calif.) at 5:30 p.m. Monday, strategists concluded they were already getting credit for what was happening but that voters wanted much more. So Pelosi, according to aides at the meeting, insisted that Democrats coordinate their message and dictated what that message would be: The general's plan meant 10 more years of war, or even "endless war."

Yes, yes, Pelosi is the one to blame for the failure of a compromise to emerge, even though what Bush (pardon me, "Petraeus") proposed wasn't a compromise at all, unless "keep as many troops in Iraq as possible for as long as possible" now counts as a compromise. And it keeps going on like that. They warn that Barack Obama and Hillary Clinton may be unable to bring the congress together because "Even if they could find a compromise that enough Republicans would accept, it is not clear that the candidates would agree to anything but a hard-line position given the antiwar fervor in the party base." This fervent party base would, I take it, be the 60-70 percent of the American public who wants to see drawdowns in Iraq and these base-beholden presidential candidates would, I guess, be the ones who are sticking to their base-displeasing stances in favor of residual forces in Iraq.

In contrast to these intransigent Democrats, Baker and Weisman suggest that Bush "has signaled that he is starting to shift." Really? I guess so:

In fact, although senior officials did not use the term "exit strategy," the outlines of one emerged from the various statements and speeches they made last week. Petraeus plans to begin redefining his mission in December from leading combat operations to partnering with Iraqi security units and eventually to supporting them. At least 21,700 troops, and perhaps more from the buildup, will be pulled out by July. Defense Secretary Robert M. Gates told reporters he hopes to bring the overall force, now at 168,000, down to 100,000 by the end of next year. And Petraeus told The Washington Post that he foresees "sustainable security" in Iraq by June 2009, a point at which the U.S. presence could be scaled back even more.

Now, again, what happened here is that Petraeus said that some troops will be withdrawn when it is no longer possible to avoid withdrawing that. At that point, we'll have as many troops in Iraq as we did a year ago. After that, Petraeus gave us a chart that contained no dates and where the final point still had tens of thousands of American soldiers in Iraq. That's not an exit strategy. And, indeed, a couple of paragraphs later they note that Bush "made no commitment to do anything beyond the initial drawdown of forces sent for the buildup." But this is the key point -- there was no compromise! They then go to Peter Rodman, a former Don Rumsfeld aide now cooling his heels at Brookings, and who "said he was particularly surprised at how Democratic presidential candidates reacted to Bush because they have a vested interest should they win the White House."

I'm ready to explode. The goal, in article-writing, should be that a person who reads your article comes away from it with a better understanding of the subject -- this does the reverse.

Edward Bellamy is a Boston social reformer writing at the very end of the ninteenth century. Even though the America of his day is much richer than the America in which he was born, he sees major flaws in American society. He also, however, sees a great deal of hope.

React to Edward Bellamy's Looking Backward in 500 words (i.e., papers of less than 450 words or more than 800 words will received grouchy readings). Consider some of the following:

What are the major flaws that Bellamy sees in America of his day?

What does Bellamy think of markets?

What does Bellamy think of immigration?

What does Bellamy think of technology?

What does Bellamy hope the future will hold in the way of technology?

What does Bellamy hope the future will hold in the way of social organization?

What does Bellamy hope the future will hold in the way of economic institutions?

What are Bellamy's major fears?

Which of his hopes and fears have been realized over the course of the past century?

From Paul Krugman this morning. I disagree with Paul's claim that tax cuts looked unlikely at the start of 2001. Presidents who propose tax cuts almost invariably get them. When was the last time congress refused to approve a president's tax cut? I cannot think of one:

Sad Alan’s Laments: When President Bush first took office, it seemed unlikely that he would succeed in getting his proposed tax cuts enacted. The questionable nature of his installation in the White House seemed to leave him in a weak political position, while the Senate was evenly balanced between the parties. It was hard to see how a huge, controversial tax cut, which delivered most of its benefits to a wealthy elite, could get through Congress.

Then Alan Greenspan, the chairman of the Federal Reserve, testified before the Senate Budget Committee. Until then Mr. Greenspan had presented himself as the voice of fiscal responsibility.... Suddenly, his greatest concern — the “emerging key fiscal policy need,” he told Congress — was to avert the threat that the federal government might actually pay off all its debt. To avoid this awful outcome, he advocated tax cuts. And the floodgates were opened....

Mr. Greenspan has just published a book in which he castigates the Bush administration for its fiscal irresponsibility. Well, I’m sorry, but that criticism comes six years late and a trillion dollars short. Mr. Greenspan now says that he didn’t mean to give the Bush tax cuts a green light, and that he was surprised at the political reaction to his remarks. There were, indeed, rumors at the time — which Mr. Greenspan now says were true — that the Fed chairman was upset about the response to his initial statement.

But the fact is that if Mr. Greenspan wasn’t intending to lend crucial support to the Bush tax cuts, he had ample opportunity to set the record straight when it could have made a difference. His first big chance to clarify himself came a few weeks after that initial testimony, when he appeared before the Senate Committee on Banking, Housing and Urban Affairs.

Here’s what I wrote following that appearance:

Mr. Greenspan’s performance yesterday, in his first official testimony since he let the genie out of the bottle, was a profile in cowardice. Again and again he was offered the opportunity to say something that would help rein in runaway tax-cutting; each time he evaded the question, often replying by reading from his own previous testimony. He declared once again that he was speaking only for himself, thus granting himself leeway to pronounce on subjects far afield of his role as Federal Reserve chairman. But when pressed on the crucial question of whether the huge tax cuts that now seem inevitable are too large, he said it was inappropriate for him to comment on particular proposals...

I received an irate phone call from Mr. Greenspan after that article, in which he demanded to know what he had said that was wrong.... Mr. Greenspan’s argument for tax cuts was contorted and in places self-contradictory, not to mention based on budget projections that everyone knew, even then, were wildly overoptimistic.

If anyone had doubts about Mr. Greenspan’s determination not to inconvenience the Bush administration, those doubts were resolved two years later, when the administration proposed another round of tax cuts, even though the budget was now deep in deficit. And guess what? The former high priest of fiscal responsibility did not object. And in 2004 he expressed support for making the Bush tax cuts permanent — remember, these are the tax cuts he now says he didn’t endorse — and argued that the budget should be balanced with cuts in entitlement spending, including Social Security benefits, instead. Of course, back in 2001 he specifically assured Congress that cutting taxes would not threaten Social Security.

In retrospect, Mr. Greenspan’s moral collapse in 2001 was a portent...

We are live at the LA Times with my review of Alan Greenspan's The Age of Turbulence. Here is the beginning:

'The Age of Turbulence' by Alan Greenspan - Los Angeles Times: FOR nearly 20 years Alan Greenspan, as head of America's central bank, was the most powerful economic central planner the world has ever seen. What did he do? Roughly twice a year, the Federal Reserve chairman had to make a substantive decision about whether to raise, lower or keep the level of U.S. interest rates the same.

Why is that important? To lower interest rates is to make the future more valuable relative to the present; to raise interest rates is to make the future less valuable. When the future is more valuable, more people in the economy focus their eyes on it and more actions are taken that will have an effect in the future: the building of factories, investment in research, construction of houses and apartments. To lower interest rates is to shift economic attention and focus from the present to the future. To raise them is to shift that balance back again.

Isn't this odd? Don't we have a market economy? Why should a central planner be setting interest rates? The only reason is that this system appears to work less badly than the alternatives we have tried. Institutions and human psychology lead financial markets to bounce back and forth between exuberant greed and catatonic fear. Times of fear generate high unemployment. Times of greed are likely to be times of destabilizing inflation. Whether the justification is in the terms of Milton Friedman, John Maynard Keynes or -- as Greenspan put it early in the Clinton administration, confusing everybody -- the pre-Keynesian Swedish school, economies seem to function better when intelligent, skilled and public-spirited technocrats perform the calming, coordinating and leaning-against-the-wind role of managing interest rates to curb greed and fortify fear with some low-interest-rate courage.

Greenspan is world famous because he was very good and very lucky at this role...

'The Age of Turbulence' by Alan Greenspan

The oracle speaks on life, money and politics.
By J. Bradford DeLong, Special to The Times
September 17, 2007

For nearly 20 years Alan Greenspan, as head of America's central bank, was the most powerful economic central planner the world has ever seen. What did he do? Roughly twice a year, the Federal Reserve chairman had to make a substantive decision about whether to raise, lower or keep the level of U.S. interest rates the same.

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Why is that important? To lower interest rates is to make the future more valuable relative to the present; to raise interest rates is to make the future less valuable. When the future is more valuable, more people in the economy focus their eyes on it and more actions are taken that will have an effect in the future: the building of factories, investment in research, construction of houses and apartments. To lower interest rates is to shift economic attention and focus from the present to the future. To raise them is to shift that balance back again.

Isn't this odd? Don't we have a market economy? Why should a central planner be setting interest rates? The only reason is that this system appears to work less badly than the alternatives we have tried. Institutions and human psychology lead financial markets to bounce back and forth between exuberant greed and catatonic fear. Times of fear generate high unemployment. Times of greed are likely to be times of destabilizing inflation. Whether the justification is in the terms of Milton Friedman, John Maynard Keynes or -- as Greenspan put it early in the Clinton administration, confusing everybody -- the pre-Keynesian Swedish school, economies seem to function better when intelligent, skilled and public-spirited technocrats perform the calming, coordinating and leaning-against-the-wind role of managing interest rates to curb greed and fortify fear with some low-interest-rate courage.

Greenspan is world famous because he was very good and very lucky at this role. During his tenure at the Federal Reserve, he made roughly 36 substantive decisions about the direction interest rates should go. Six times I disagreed with him. Five of those six times, I was wrong. (The sixth? In the summer and fall of 2000, as the dot-com stock-market bubble crashed, I would have been cutting interest rates had I been sitting in Greenspan's chair; he waited for more information to see how much the fall in stock-market values would affect high-tech investment spending before he acted.)

That is an amazing record -- much better than Barry Bonds', and Greenspan clearly has never been on steroids. It is certainly much better than most economists I know could have done. Now this veritable rock-star economist-technocrat has written "The Age of Turbulence" with Peter Petre (who wrote the autobiographies of Gen. H. Norman Schwartzkopf and IBM head Thomas J. Watson Jr.). The voice in the book is Petre's. In a sense, this is too bad: Greenspan's voice is unique and a good window into his mind. But it is also nearly incomprehensible, even to trained professionals. And Petre has done a superb job of translating Greenspanese into English.

"The Age of Turbulence" is three books in one.

The first tells us who Greenspan is. It is the one that will speak to non-economist non-financier readers. The stories are wonderful: of a professional-caliber jazz clarinetist in New York in the 1950s, playing his sets and then reading his economics books during the breaks while fellow musicians go backstage to party and get high. Of a 26-year-old "math junkie" being knocked back on his heels by his philosophical guru, Ayn Rand, objectivist author of "The Fountainhead" and "Atlas Shrugged," when she pulls Descartes' "I think, therefore I exist" move on him. Of an economic advisor trying to educate, serve and guide Presidents Nixon, Ford, Reagan, Bush I, Clinton and Bush II. (Nixon wasn't just anti-Semitic, Greenspan tells us, but anti-everyone: "I don't know anybody he was pro.") Of inviting NBC News correspondent Andrea Mitchell, now Mrs. Greenspan, back to his apartment to read his essay on monopolies.

The second book gives Greenspan's view of the world and is, I think, least successful. He is trying to convey complicated and subtle technocratic ideas about the global economy -- its current structure and how it functions -- in a way that is comprehensible to general readers whose purchases drive bestseller lists. My students will read it because it will be on the midterm. But the book's target audience is likely to find this world tour a slog, and they are not incentivized by midterms.

The third book -- Greenspan's account of public policy -- is making the biggest splash as news. But it is news only in a very peculiar sense. That Greenspan and other committed small-government Republicans have been horrified at the turn their party has taken and have desperately sought some way to take it back from the cynical media consultants and political hacks who now run things is well-known -- to readers of Ron Suskind's "The Price of Loyalty" and Bruce Bartlett's "Imposter" and a host of people who know people who know Bush administration undersecretaries. Greenspan's much-quoted judgment in the book -- that current Republican office holders "deserve to lose" elections because they sold their principles for power and "ended up with neither" -- should come as no secret. Yet stories over the last few days have breathlessly reported selected phrases from the new book, characterizing them, as the Washington Post's Bob Woodward did, as "unusually harsh criticism [of] President Bush and the Republican Party" for abandoning "the central conservative principle of fiscal restraint."

It is not surprising that a prominent economist with a lifelong commitment to sound money and sound public finance does not like the policies the current government has followed.

One piece of this third book is worth noting: Greenspan's defense of his tenure as Fed chief. Why does he need a defense? Thirty-five out of 36 decisions is a very good batting average. But one could indict him on four counts: that he should not have, but did, support the Bush tax cut of 2001; that he should not have, but did, encourage new U.S. homeowners to get adjustable-rate mortgages -- ARMs -- in the early 2000s; that he should have done something to abort the dot-com bubble of the late 1990s; and that he should have done something to prevent the real estate bubble of the 2000s.

The first two counts are misdemeanors, and Greenspan pleads guilty. He says that he was warned that his testimony on the proposed 2001 tax cut would send a different message than he intended and that he ignored those warnings, which proved correct. Greenspan says his support for a tax cut was nuanced and partial, provided there were triggers to prevent budget deficits but that his statements were interpreted by the news media and politicians as a blanket endorsement. He adds that he did not understand how institutionally corrupt and thus unconcerned about good budget policy his Republican Party had become by early 2001. He says he did not properly understand in the early 2000s the large effect low teaser interest rates and prepayment penalties would have in leading new and financially strapped homeowners into deals that were not in their best interest.

The other two counts could be considered economic felonies, and here Greenspan stands his ground. Given the state of investor psychology, he says, he could have aborted the stock market and housing bubbles of the late 1990s and the early 2000s but only by paying an unacceptable price in idled factories and unemployed workers. He may be right and he may be wrong in this judgment -- I don't know. I do know that this is a judgment call, a difficult aspect of monetary policy.

I also know that Greenspan's judgment on monetary policy is very good, and looks to be better than mine.

J. Bradford DeLong, a former deputy assistant U.S. Treasury secretary, is a professor of economics at UC Berkeley.

The Avalon Project: Madison Debates : September 17:IN CONVENTION: The engrossed Constitution being read, Docr. FRANKLIN rose with a speech in his hand, which he had reduced to writing for his own conveniency, and which Mr. Wilson read in the words following.

Mr. President

I confess that there are several parts of this constitution which I do not at present approve, but I am not sure I shall never approve them: For having lived long, I have experienced many instances of being obliged by better information, or fuller consideration, to change opinions even on important subjects, which I once thought right, but found to be otherwise. It is therefore that the older I grow, the more apt I am to doubt my own judgment, and to pay more respect to the judgment of others. Most men indeed as well as most sects in Religion, think themselves in possession of all truth, and that wherever others differ from them it is so far error. Steele a Protestant in a Dedication tells the Pope, that the only difference between our Churches in their opinions of the certainty of their doctrines is, the Church of Rome is infallible and the Church of England is never in the wrong. But though many private persons think almost as highly of their own infallibility as of that of their sect, few express it so naturally as a certain french lady, who in a dispute with her sister, said "I don't know how it happens, Sister but I meet with no body but myself, that's always in the right--Il n'y a que moi qui a toujours raison."

In these sentiments, Sir, I agree to this Constitution with all its faults, if they are such; because I think a general Government necessary for us, and there is no form of Government but what may be a blessing to the people if well administered, and believe farther that this is likely to be well administered for a course of years, and can only end in Despotism, as other forms have done before it, when the people shall become so corrupted as to need despotic Government, being incapable of any other. I doubt too whether any other Convention we can obtain, may be able to make a better Constitution. For when you assemble a number of men to have the advantage of their joint wisdom, you inevitably assemble with those men, all their prejudices, their passions, their errors of opinion, their local interests, and their selfish views. From such an assembly can a perfect production be expected? It therefore astonishes me, Sir, to find this system approaching so near to perfection as it does; and I think it will astonish our enemies, who are waiting with confidence to hear that our councils are confounded like those of the Builders of Babel; and that our States are on the point of separation, only to meet hereafter for the purpose of cutting one another's throats. Thus I consent, Sir, to this Constitution because I expect no better, and because I am not sure, that it is not the best. The opinions I have had of its errors, I sacrifice to the public good. I have never whispered a syllable of them abroad. Within these walls they were born, and here they shall die. If every one of us in returning to our Constituents were to report the objections he has had to it, and endeavor to gain partizans in support of them, we might prevent its being generally received, and thereby lose all the salutary effects & great advantages resulting naturally in our favor among foreign Nations as well as among ourselves, from our real or apparent unanimity. Much of the strength & efficiency of any Government in procuring and securing happiness to the people, depends, on opinion, on the general opinion of the goodness of the Government, as well as well as of the wisdom and integrity of its Governors. I hope therefore that for our own sakes as a part of the people, and for the sake of posterity, we shall act heartily and unanimously in recommending this Constitution (if approved by Congress & confirmed by the Conventions) wherever our influence may extend, and turn our future thoughts & endeavors to the means of having it well administred.

On the whole, Sir, I can not help expressing a wish that every member of the Convention who may still have objections to it, would with me, on this occasion doubt a little of his own infallibility, and to make manifest our unanimity, put his name to this instrument.-

He then moved that the Constitution be signed by the members and offered the following as a convenient form viz. "Done in Convention by the unanimous consent of the States present the 17th. of Sepr. &c--In Witness whereof we have hereunto subscribed our names."

This ambiguous form had been drawn up by Mr. G. M. in order to gain the dissenting members, and put into the hands of Docr. Franklin that it might have the better chance of success....

The members then proceeded to sign the instrument.

Whilst the last members were signing it, Doctr. FRANKLIN looking towards the Presidents Chair, at the back of which a rising sun happened to be painted, observed to a few members near him, that Painters had found it difficult to distinguish in their art a rising from a setting sun. "I have," said he, "often and often in the course of the Session, and the vicisitudes of my hopes and fears as to its issue, looked at that behind the President without being able to tell whether it was rising or setting: But now at length I have the happiness to know that it is a rising and not a setting Sun."

September 16, 2007

Sweating the Small Stuff (Aaron Swartz's Raw Thought): So Jottit has launched, only five months after I suggested to my friend Simon that we create a website that was just a big text box people could type stuff into. And there are two ways I look at it. One is: It took us five months to do that? And the other is: We did that in only five months?

When you look at what the site does, it seems pretty simple. It has few features, no complex algorithms, little gee-whiz gadgetry. It just takes your text and puts it on the Web. And considering how often I do that every day, it seems a bid odd that it took so long to create yet another way. And then I check the todo list.

As I've said, this is a site I wanted to get every little detail right on. And when you start sweating the small stuff, it's frankly incredible just how much of it there is. Even our trivial site is made up of over two dozen different screens. Each one of those screens has to be designed to look and work just right on a wide variety of browsers, with a wide variety of text in them.

And that's just making things look good -- making them work right is much harder. Each screen does, on average, five or six different things. And each of those things can be done under three or four different modes. Now we're up to over 500 different things to do, each of which can have bugs in lots of unthought-of ways. And then, many of these pieces are exposed to users, who can do whatever they want with them -- and do. If you're building a site that accepts text from users, you need to think about something that lets some people just paste stuff from emails, others write HTML, others play YouTube videos, while others try to insert malicious text to break things for people.

There are lots of features we want to add to Jottit, but before we do any of that we want to make what we have work perfectly. And, at the moment, that means tasks as varied as reporting a bug in a piece of software we use to its developer, configuring the web server to display a nicer error message under certain odd conditions, having another computer monitor the first computer to see if it goes down, figuring out how to tweak the UI to make certain unclear things clearer to people, rewriting some of the text on the site to be nicer, creating a new site to inform our users of updates, making some stuff from our project open source, fixing stuff in other open source projects, testing the site on phones and weird browsers, examining an algorithm we use to see if it needs improvement, and fixing a bug that was just reported by a user. And those are just the things on my todo list!

When you look at it that way, it's amazing anyone ever builds a website.

Admittedly, it is seventeen years since he published volume I of The Road to Disunion: Secessionists at Bay. Nevertheless, I thought it would have made a bigger splash. If it is 1/2 as good as its predecessor, it is the must-read history book of the year.

Global Alpha, Carry Trade Victim: Bloomberg reports that Goldman's big hedge fund, Global Alpha, which took a beating along with other quantitatively oriented traders, was down 22.5% in August. Even among quant funds, this was lackluster performance. James Simons' Renaissance Technologies recouped the 8.7% loss it suffered at the beginning of the month.

But here comes the juicy bit: of that 22.5% loss, the biggest contributor was an 8.9% fall in currencies due to being hit by an unwinding of the carry trade. The fund had sold yen and bought Aussie dollars, and the Australian dollar fell 6% while the yen rose.

Let's get this picture straight. Goldman is charging hedge fund fees and claiming to deserve them by virtue of having highly sophisticated models, and one of its biggest positions in a yen/Aussie dollar bet? You don't need Goldman for that. Japanese housewives are doing far more complicated currency trades on their own. They can try to hide behind their models, but this is plain simple point of view punting on currencies.

But Goldman would have you believe otherwise:

"Longer term, successful quant managers will have to rely more on unique factors," the firm's fund-management division said in a report to clients. "While we have developed a number of these factors over the last several years, in hindsight we did not put sufficient weight on these relative to more popular quant factors."

The claim that too many other quants were making the same trade is utter baloney. Huge numbers of Japanese speculators were into that trade. Everyone knew that. Every time the yen stated to appreciate, retail traders in Japan would sell it down, until even they lost their nerve...

Felix Salmon condemns the low quality of the arguments of G.M.'s advocates:

Market Movers: GM's Weak Arguments Against Increased Fuel Economy - Portfolio.com: What wonders of disingenuousness the auto industry is capable of! Right now, the Big Three are worried about proposals to mandate that they increase the fuel economy of the vehicles they sell, and so they're wheeling out economists to say that the proposals don't make sense. But one would think they could do better than this.

The economists (Robert Crandall and Hal Singer)... my favorite part of the whole piece:

If there was fuel-saving technology out there that cost $1,000 but generated $2,500 in the discounted present value of fuel savings over the life of the vehicle, carmakers would surely voluntarily embrace that technology. The carmaker could split the net benefits (equal to the difference between the discounted fuel savings and the cost of the technology) with the car buyer such that both parties to the transaction would be better off.

No need for regulation there. With large numbers of vehicle producers and well-informed consumers, the market is so efficient, in fact, that it ensures that all such transactions will occur, generating the socially optimal level of fuel economy....

"Socially optimal" only if the price of gasoline is at its socially-optimal level--which it is not. And "socially optimal" only if people buy cars entirely because they are useful, and not at all as counters in a zero-sum East African Plains Ape status game.

Let me 100% endorse what Alex Tabarrok has to say. A university is a social institution in which people are supposed to think and then speak without fear or favor. The University of California is not doing a good job this week:

In a showdown over academic freedom, a prominent legal scholar said Wednesday that the University of California, Irvine's chancellor had succumbed to conservative political pressure in rescinding his contract to head the university's new law school, a charge the chancellor vehemently denied.

Erwin Chemerinsky, a well-known liberal expert on constitutional law, said he had signed a contract Sept. 4, only to be told Tuesday by Chancellor Michael V. Drake that he was voiding their deal because Chemerinsky was too liberal and the university had underestimated "conservatives out to get me."

Now this:

After a group of UC Davis women faculty began circulating a petition, UC regents rescinded an invitation to Larry Summers, the controversial former president of Harvard University, to speak at a board dinner Wednesday night in Sacramento.

Testimony of Chairman Alan Greenspan: "Outlook for the federal budget and implications for fiscal policy." Before the Committee on the Budget, U.S. Senate. January 25, 2001:

FRB: Testimony, Greenspan, January 25, 2001: I am pleased to appear here today to discuss some of the important issues surrounding the outlook for the federal budget and the attendant implications for the formulation of fiscal policy. In doing so, I want to emphasize that I speak for myself and not necessarily for the Federal Reserve.

The challenges you face both in shaping a budget for the coming year and in designing a longer-run strategy for fiscal policy were brought into sharp focus by the release last week of the Clinton Administration's final budget projections, which showed further upward revisions of on-budget surpluses for the next decade. The Congressional Budget Office also is expected to again raise its projections when it issues its report next week.

The key factor driving the cumulative upward revisions in the budget picture in recent years has been the extraordinary pickup in the growth of labor productivity experienced in this country since the mid-1990s. Between the early 1970s and 1995, output per hour in the nonfarm business sector rose about 1-1/2 percent per year, on average. Since 1995, however, productivity growth has accelerated markedly, about doubling the earlier pace, even after taking account of the impetus from cyclical forces. Though hardly definitive, the apparent sustained strength in measured productivity in the face of a pronounced slowing in the growth of aggregate demand during the second half of last year was an important test of the extent of the improvement in structural productivity. These most recent indications have added to the accumulating evidence that the apparent increases in the growth of output per hour are more than transitory.

It is these observations that appear to be causing economists, including those who contributed to the OMB and the CBO budget projections, to raise their forecasts of the economy's long-term growth rates and budget surpluses. This increased optimism receives support from the forward-looking indicators of technical innovation and structural productivity growth, which have shown few signs of weakening despite the marked curtailment in recent months of capital investment plans for equipment and software.

To be sure, these impressive upward revisions to the growth of structural productivity and economic potential are based on inferences drawn from economic relationships that are different from anything we have considered in recent decades. The resulting budget projections, therefore, are necessarily subject to a relatively wide range of error. Reflecting the uncertainties of forecasting well into the future, neither the OMB nor the CBO projects productivity to continue to improve at the stepped-up pace of the past few years. Both expect productivity growth rates through the next decade to average roughly 2-1/4 to 2-1/2 percent per year--far above the average pace from the early 1970s to the mid-1990s, but still below that of the past five years.

Had the innovations of recent decades, especially in information technologies, not come to fruition, productivity growth during the past five to seven years, arguably, would have continued to languish at the rate of the preceding twenty years. The sharp increase in prospective long-term rates of return on high-tech investments would not have emerged as it did in the early 1990s, and the associated surge in stock prices would surely have been largely absent. The accompanying wealth effect, so evidently critical to the growth of economic activity since the mid 1990s, would never have materialized.

In contrast, the experience of the past five to seven years has been truly without recent precedent. The doubling of the growth rate of output per hour has caused individuals' real taxable income to grow nearly 2-1/2 times as fast as it did over the preceding ten years and resulted in the substantial surplus of receipts over outlays that we are now experiencing. Not only did taxable income rise with the faster growth of GDP, but the associated large increase in asset prices and capital gains created additional tax liabilities not directly related to income from current production.

The most recent projections from the OMB indicate that, if current policies remain in place, the total unified surplus will reach $800 billion in fiscal year 2011, including an on-budget surplus of $500 billion. The CBO reportedly will be showing even larger surpluses. Moreover, the admittedly quite uncertain long-term budget exercises released by the CBO last October maintain an implicit on-budget surplus under baseline assumptions well past 2030 despite the budgetary pressures from the aging of the baby-boom generation, especially on the major health programs.

The most recent projections, granted their tentativeness, nonetheless make clear that the highly desirable goal of paying off the federal debt is in reach before the end of the decade. This is in marked contrast to the perspective of a year ago when the elimination of the debt did not appear likely until the next decade.

But continuing to run surpluses beyond the point at which we reach zero or near-zero federal debt brings to center stage the critical longer-term fiscal policy issue of whether the federal government should accumulate large quantities of private (more technically nonfederal) assets. At zero debt, the continuing unified budget surpluses currently projected imply a major accumulation of private assets by the federal government. This development should factor materially into the policies you and the Administration choose to pursue.

I believe, as I have noted in the past, that the federal government should eschew private asset accumulation because it would be exceptionally difficult to insulate the government's investment decisions from political pressures. Thus, over time, having the federal government hold significant amounts of private assets would risk sub-optimal performance by our capital markets, diminished economic efficiency, and lower overall standards of living than would be achieved otherwise.

Short of an extraordinarily rapid and highly undesirable short-term dissipation of unified surpluses or a transferring of assets to individual privatized accounts, it appears difficult to avoid at least some accumulation of private assets by the government.

Private asset accumulation may be forced upon us well short of reaching zero debt. Obviously, savings bonds and state and local government series bonds are not readily redeemable before maturity. But the more important issue is the potentially rising cost of retiring marketable Treasury debt. While shorter-term marketable securities could be allowed to run off as they mature, longer-term issues would have to be retired before maturity through debt buybacks. The magnitudes are large: As of January 1, for example, there was in excess of three quarters of a trillion dollars in outstanding nonmarketable securities, such as savings bonds and state and local series issues, and marketable securities (excluding those held by the Federal Reserve) that do not mature and could not be called before 2011. Some holders of long-term Treasury securities may be reluctant to give them up, especially those who highly value the risk-free status of those issues. Inducing such holders, including foreign holders, to willingly offer to sell their securities prior to maturity could require paying premiums that far exceed any realistic value of retiring the debt before maturity.

Decisions about what type of private assets to acquire and to which federal accounts they should be directed must be made well before the policy is actually implemented, which could occur in as little as five to seven years from now. These choices have important implications for the balance of saving and, hence, investment in our economy. For example, transferring government saving to individual private accounts as a means of avoiding the accumulation of private assets in the government accounts could significantly affect how social security will be funded in the future.

Short of some privatization, it would be preferable in my judgment to allocate the required private assets to the social security trust funds, rather than to on-budget accounts. To be sure, such trust fund investments are subject to the same concerns about political pressures as on-budget investments would be. The expectation that the retirement of the baby-boom generation will eventually require a drawdown of these fund balances does, however, provide some mitigation of these concerns.

Returning to the broader picture, I continue to believe, as I have testified previously, that all else being equal, a declining level of federal debt is desirable because it holds down long-term real interest rates, thereby lowering the cost of capital and elevating private investment. The rapid capital deepening that has occurred in the U.S. economy in recent years is a testament to these benefits. But the sequence of upward revisions to the budget surplus projections for several years now has reshaped the choices and opportunities before us. Indeed, in almost any credible baseline scenario, short of a major and prolonged economic contraction, the full benefits of debt reduction are now achieved before the end of this decade--a prospect that did not seem likely only a year or even six months ago.

The most recent data significantly raise the probability that sufficient resources will be available to undertake both debt reduction and surplus-lowering policy initiatives. Accordingly, the tradeoff faced earlier appears no longer an issue. The emerging key fiscal policy need is to address the implications of maintaining surpluses beyond the point at which publicly held debt is effectively eliminated.

The time has come, in my judgement, to consider a budgetary strategy that is consistent with a preemptive smoothing of the glide path to zero federal debt or, more realistically, to the level of federal debt that is an effective irreducible minimum. Certainly, we should make sure that social security surpluses are large enough to meet our long-term needs and seriously consider explicit mechanisms that will help ensure that outcome. Special care must be taken not to conclude that wraps on fiscal discipline are no longer necessary. At the same time, we must avoid a situation in which we come upon the level of irreducible debt so abruptly that the only alternative to the accumulation of private assets would be a sharp reduction in taxes and/or an increase in expenditures, because these actions might occur at a time when sizable economic stimulus would be inappropriate. In other words, budget policy should strive to limit potential disruptions by making the on-budget surplus economically inconsequential when the debt is effectively paid off.

In general, as I have testified previously, if long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases. The flurry of increases in outlays that occurred near the conclusion of last fall's budget deliberations is troubling because it makes the previous year's lack of discipline less likely to have been an aberration.

To be sure, with the burgeoning federal surpluses, fiscal policy has not yet been unduly compromised by such actions. But history illustrates the difficulty of keeping spending in check, especially in programs that are open-ended commitments, which too often have led to much larger outlays than initially envisioned. It is important to recognize that government expenditures are claims against real resources and that, while those claims may be unlimited, our capacity to meet them is ultimately constrained by the growth in productivity. Moreover, the greater the drain of resources from the private sector, arguably, the lower the growth potential of the economy. In contrast to most spending programs, tax reductions have downside limits. They cannot be open-ended.

Lately there has been much discussion of cutting taxes to confront the evident pronounced weakening in recent economic performance. Such tax initiatives, however, historically have proved difficult to implement in the time frame in which recessions have developed and ended. For example, although President Ford proposed in January of 1975 that withholding rates be reduced, this easiest of tax changes was not implemented until May, when the recession was officially over and the recovery was gathering force. Of course, had that recession lingered through the rest of 1975 and beyond, the tax cuts would certainly have been helpful. In today's context, where tax reduction appears required in any event over the next several years to assist in forestalling the accumulation of private assets, starting that process sooner rather than later likely would help smooth the transition to longer-term fiscal balance. And should current economic weakness spread beyond what now appears likely, having a tax cut in place may, in fact, do noticeable good.

As for tax policy over the longer run, most economists believe that it should be directed at setting rates at the levels required to meet spending commitments, while doing so in a manner that minimizes distortions, increases efficiency, and enhances incentives for saving, investment, and work.

In recognition of the uncertainties in the economic and budget outlook, it is important that any long-term tax plan, or spending initiative for that matter, be phased in. Conceivably, it could include provisions that, in some way, would limit surplus-reducing actions if specified targets for the budget surplus and federal debt were not satisfied. Only if the probability was very low that prospective tax cuts or new outlay initiatives would send the on-budget accounts into deficit, would unconditional initiatives appear prudent.

The reason for caution, of course, rests on the tentativeness of our projections. What if, for example, the forces driving the surge in tax revenues in recent years begin to dissipate or reverse in ways that we do not now foresee? Indeed, we still do not have a full understanding of the exceptional strength in individual income tax receipts during the latter 1990s. To the extent that some of the surprise has been indirectly associated with the surge in asset values in the 1990s, the softness in equity prices over the past year has highlighted some of the risks going forward.

Indeed, the current economic weakness may reveal a less favorable relationship between tax receipts, income, and asset prices than has been assumed in recent projections. Until we receive full detail on the distribution by income of individual tax liabilities for 1999, 2000, and perhaps 2001, we are making little more than informed guesses of certain key relationships between income and tax receipts.

To be sure, unless later sources do reveal major changes in tax liability determination, receipts should be reasonably well-maintained in the near term, as the effects of earlier gains in asset values continue to feed through with a lag into tax liabilities. But the longer-run effects of movements in asset values are much more difficult to assess, and those uncertainties would intensify should equity prices remain significantly off their peaks. Of course, the uncertainties in the receipts outlook do seem less troubling in view of the cushion provided by the recent sizable upward revisions to the ten-year surplus projections. But the risk of adverse movements in receipts is still real, and the probability of dropping back into deficit as a consequence of imprudent fiscal policies is not negligible.

In the end, the outlook for federal budget surpluses rests fundamentally on expectations of longer-term trends in productivity, fashioned by judgments about the technologies that underlie these trends. Economists have long noted that the diffusion of technology starts slowly, accelerates, and then slows with maturity. But knowing where we now stand in that sequence is difficult--if not impossible--in real time. As the CBO and the OMB acknowledge, they have been cautious in their interpretation of recent productivity developments and in their assumptions going forward. That seems appropriate given the uncertainties that surround even these relatively moderate estimates for productivity growth. Faced with these uncertainties, it is crucial that we develop budgetary strategies that deal with any disappointments that could occur.

That said, as I have argued for some time, there is a distinct possibility that much of the development and diffusion of new technologies in the current wave of innovation still lies ahead, and we cannot rule out productivity growth rates greater than is assumed in the official budget projections. Obviously, if that turns out to be the case, the existing level of tax rates would have to be reduced to remain consistent with currently projected budget outlays.

The changes in the budget outlook over the past several years are truly remarkable. Little more than a decade ago, the Congress established budget controls that were considered successful because they were instrumental in squeezing the burgeoning budget deficit to tolerable dimensions. Nevertheless, despite the sharp curtailment of defense expenditures under way during those years, few believed that a surplus was anywhere on the horizon. And the notion that the rapidly mounting federal debt could be paid off would not have been taken seriously.

But let me end on a cautionary note. With today's euphoria surrounding the surpluses, it is not difficult to imagine the hard-earned fiscal restraint developed in recent years rapidly dissipating. We need to resist those policies that could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake.